Washington Real Estate Fundamentals
Lesson 13:
Closing Real Estate
Transactions
© 2011 Rockwell Publishing
Closing Real Estate Transactions
Closing: Final stage in a real estate
transaction; also called settlement.
 Buyer pays seller purchase price.
 Seller transfers title to buyer.
© 2011 Rockwell Publishing
Escrow
In Washington, closing process usually
handled through escrow.
Escrow: Arrangement in which third party
holds money and documents for buyer and
seller until transaction ready to close.
© 2011 Rockwell Publishing
Escrow
Appointment of escrow agent
Escrow agent: Third party selected to handle
closing; also called closing agent.
 Chosen by agreement between buyer
and seller.
 Often appointed in purchase
agreement.
 Acts as dual agent.
© 2011 Rockwell Publishing
Escrow
Escrow instructions
Escrow instructions: Document(s) signed by
buyer and seller when escrow opened.
 Direct escrow agent to take steps
necessary to close transaction.

Reflect contingencies and other
requirements in purchase agreement.

Specify conditions that must be met
before escrow agent releases funds or
documents.
© 2011 Rockwell Publishing
Escrow
Purpose and benefits
Escrow helps ensure that:
 seller receives purchase price
 buyer receives clear title
 lender’s security interest perfected
Two main benefits:
 Convenience – neither party has to
attend closing in person.
 Protection against other party’s change
of heart.
© 2011 Rockwell Publishing
Escrow
Purpose and benefits
Deposit into escrow is essentially irrevocable.
 After delivering funds or documents to
escrow agent, can’t get them back
except:
 according to conditions set forth in
escrow instructions, or
 with other party’s consent.
© 2011 Rockwell Publishing
Escrow
Escrow agent’s services
Escrow agent may provide many services:
 ordering title report and inspections
 paying off seller’s loan and other liens
 preparing documents
 prorating and allocating expenses
 depositing and disbursing funds
 preparing settlement statement
 delivering and recording documents
© 2011 Rockwell Publishing
Escrow
Escrow Agent Registration Act
Washington statute requires escrow agents to
be licensed and registered with Department
of Financial Institutions.
© 2011 Rockwell Publishing
Escrow Agent Registration Act
Licensed escrow agent
Licensed escrow agent: Company licensed to
engage in escrow business in Washington
under Escrow Agent Registration Act.
© 2011 Rockwell Publishing
Escrow Agent Registration Act
Licensed escrow agent
Licensed escrow agent (company) must:
 comply with bonding requirements
 have errors and omissions insurance
 keep transaction records
 maintain a client trust account
 employ only licensed escrow officers to
handle transactions
© 2011 Rockwell Publishing
Escrow Agent Registration Act
Licensed escrow officer
Licensed escrow officer: Individual licensed to
handle transactions as representative of
licensed escrow agent (company).
 Licensed escrow officer must:
 pass state exam and meet other
requirements
 be supervised by company’s
designated escrow officer
© 2011 Rockwell Publishing
Escrow Agent Registration Act
Licensing exemptions
Exempt from escrow licensing requirements:
 attorneys
 title companies
 banks, savings and loans, and credit
unions
 insurance companies
 federally approved lenders
 parties acting under court supervision
© 2011 Rockwell Publishing
Escrow Agent Registration Act
Licensing exemptions
Real estate agent exempt:
 when handling escrow for transaction in
which he is providing brokerage services
 as long as he doesn’t charge additional
fee for escrow services
© 2011 Rockwell Publishing
Summary
Escrow
•
•
•
•
•
•
•
•
•
Closing or settlement
Escrow
Escrow agent or closing agent
Escrow instructions
Escrow Agent Registration Act
Licensed escrow agent
Licensed escrow officer
Designated escrow officer
Exemptions
© 2011 Rockwell Publishing
Closing Costs
Closing costs: Fees, charges, and expenses
related to a real estate transaction that are
typically paid at closing.

Particular cost may be paid by buyer or
by seller, or shared by both.

Either party may have to pay:
 the other party
 a third party
© 2011 Rockwell Publishing
Closing Costs
Allocation
Purchase agreement form and/or escrow
instructions often state which party is
responsible for certain closing costs.

Buyer and seller may agree to different
allocation and modify contract form.

Costs not addressed in contract allocated
by escrow agent according to custom.
© 2011 Rockwell Publishing
Settlement Statements
Settlement statement: Document that sets out
financial details of transaction, providing an
accounting for buyer and seller. Also called a
closing statement.
 Lists closing costs, all other payments
into and out of escrow.
 Shows how much cash:
 buyer will need for closing
 seller will receive at closing
© 2011 Rockwell Publishing
Settlement Statements
Escrow agent prepares settlement statement
for each party when sale ready to close.

For most home sales, uniform settlement
statement form (HUD-1) must be used.

We’ll describe simplified format, to make
settlement statements easy to
understand.
© 2011 Rockwell Publishing
Settlement Statements
Four-column format
Simplified settlement statement has four
columns:
 buyer’s debits
 buyer’s credits
 seller’s debits
 seller’s credits
© 2011 Rockwell Publishing
Settlement Statements
Debits and credits
Debit: An amount to be paid by
one of the parties.
Credit: An amount to be paid to
one of the parties.
© 2011 Rockwell Publishing
Settlement Statements
Amounts one party pays the other
Amounts paid by one party to the other party
are a debit for one and a credit for the other.

These are listed in two columns.

Example: Purchase price
 Listed in buyer’s debit column.
 Also listed in seller’s credit column.
© 2011 Rockwell Publishing
Settlement Statements
Amounts paid to or by third party
Amounts one party pays to or receives from a
third party are listed in only one column.

Example: Loan origination fee
 Buyer owes fee to lender.
 Listed only in buyer’s debit column.
 Does not appear in seller’s columns.
© 2011 Rockwell Publishing
Settlement Statements
Total credits match total debits
In four-column format, each party’s total
credits should equal his or her own total
debits.
 Settlement statement like check register
for bank account.
 At closing, after all deposits (credits) and
withdrawals (debits) made, each party’s
balance should be zero.
© 2011 Rockwell Publishing
Settlement Statements
Allocation of credits and debits
Purchase price
Buyer’s debit
Seller’s credit
Earnest money deposit
Buyer’s credit
Sales commission
Seller’s debit
© 2011 Rockwell Publishing
Allocation of Credits and Debits
Buyer’s financing
Buyer’s new loan
Buyer’s credit
Assumed loan
Buyer’s credit
Seller’s debit
Seller financing
Buyer’s credit
Seller’s debit
© 2011 Rockwell Publishing
Allocation of Credits and Debits
Seller’s loan payoff
Seller’s loan payoff
Seller’s debit
Prepayment penalty
Seller’s debit
Reserve account refund
Seller’s credit
© 2011 Rockwell Publishing
Allocation of Credits and Debits
Charges connected with buyer’s loan
Appraisal fee
Buyer’s debit
Credit report fee
Buyer’s debit
Survey fee
Buyer’s debit
Loan origination fee
Buyer’s debit
Discount points
Buyer’s debit
Seller-paid points
Seller’s debit
Assumption fee
Buyer’s debit
© 2011 Rockwell Publishing
Allocation of Credits and Debits
Title insurance premiums
Owner’s title insurance
Seller’s debit
Lender’s title insurance
Buyer’s debit
© 2011 Rockwell Publishing
Allocation of Credits and Debits
Other items
Personal property
Inspection fee
Hazard insurance
Excise tax
Attorney’s fees
Recording fee
Escrow fee
Buyer’s debit
Seller’s credit
Debit to party
ordering inspection
Buyer’s debit
Seller’s debit
Debit for each party
Debit for each party
Debit for each party
© 2011 Rockwell Publishing
Summary
Settlement Statements
•
•
•
•
•
•
•
Closing cost
Settlement statement
Debit
Credit
Amounts paid by one party to the other
Amounts paid to or by a third party
Total credits and total debits
© 2011 Rockwell Publishing
Settlement Statements
Prorations
Prorate: To divide and allocate an expense
proportionately, according to time, interest, or
benefit.

Expense must be prorated if a party is
responsible for only part of it.

Escrow agent calculates share that must
be paid by or refunded to that party.
© 2011 Rockwell Publishing
Prorations
As of closing date
Responsibility for property expenses generally
begins and ends with period of ownership.
 Also true of entitlement to financial benefits.

Items commonly prorated as of closing date:
 property taxes
 mortgage interest
 insurance premiums
 rents (from income-producing property)
© 2011 Rockwell Publishing
Prorations
3 steps
1. Calculate daily rate of an expense, called
the per diem rate.
2. Determine number of days one party is
responsible for the expense.
3. Multiply number of days by per diem rate
to determine that party’s share.
© 2011 Rockwell Publishing
Prorations
Step 1: Per diem rate
To calculate per diem rate:
 Annual expense:
 divide by 365 days
 366 days in leap year
 Monthly expense:
 divide by number of days in month
when closing occurs (28, 29, 30, or 31)
© 2011 Rockwell Publishing
Prorations
Step 1: Per diem rate
Occasionally an exam question may instruct
you to use a 360-day year in order to simplify
calculations.
 If you see a question with those
instructions, assume that all months have
30 days.
© 2011 Rockwell Publishing
Prorations
Step 2: Number of days
Count number of days between closing date
and beginning or end of month in which
closing will occur.
 Beginning of month for seller’s share.
 End of month for buyer’s share.
Proration questions should tell you:
 whether to count the day of closing
 whether to use 360-day year and 30-day
months
© 2011 Rockwell Publishing
Prorations
Step 3: Rate × Days
Final step: multiply per diem rate by number
of days.
 Result is the party’s prorated share.
© 2011 Rockwell Publishing
Prorations
Prorating property taxes
Property taxes are:
 seller’s responsibility up to closing date
 buyer’s responsibility from closing date
forward
© 2011 Rockwell Publishing
Prorating Property Taxes
Paid in advance or in arrears
Taxes paid in advance:
 buyer debited for days following closing
date that advance payment covers
 seller credited for same amount
Taxes in arrears (not yet paid):
 seller debited for days before closing
date that eventual tax payment will cover
 buyer credited for same amount
© 2011 Rockwell Publishing
Prorating Property Taxes
Example
Closing date: July 14. Annual property tax bill:
$1,200.85. Seller already paid entire amount.
How much does buyer owe?
Step 1: $1,200.85 ÷ 365 days = $3.29 per diem
Step 2: 18 days (July) + 31 (Aug.) + 30 (Sept.)
+ 31 (Oct.) + 30 (Nov.) + 31 (Dec.) = 171 days
Step 3: $3.29 per diem × 171 days = $562.59
© 2011 Rockwell Publishing
Prorations
Prorating hazard insurance
Hazard insurance is paid for in advance.
 At closing, seller entitled to prorated
refund of part of premium.
 Refund is credit for seller.
Buyer not debited for prorated share unless
buyer assuming seller’s policy.
© 2011 Rockwell Publishing
Prorating Hazard Insurance
Example
Closing date: Nov. 21. Annual premium
($310.25) paid in advance, on March 1 of this
year, for coverage through Feb. 28 of next
year. How much will be refunded to seller?
$310.25 ÷ 365 = $0.85 per diem
Count days: 9 (Nov.) + 31 (Dec.) + 31 (Jan.)
+ 28 (Feb.) = 99 days
$0.85 per diem × 99 days = $84.15
© 2011 Rockwell Publishing
Prorations
Mortgage interest
Two types of mortgage interest usually must
be prorated at closing:
 final interest payment on seller’s loan
(debit for seller)
 prepaid interest for buyer’s loan
(debit for buyer)
© 2011 Rockwell Publishing
Prorating Interest
Seller’s final interest payment
Mortgage interest is paid in arrears.
 Example: Payment made April 1 includes
interest that accrued in March.
So seller’s final mortgage payment did not
include interest for month in which closing
takes place.
 Seller must pay this interest at closing.
© 2011 Rockwell Publishing
Seller’s Final Interest Payment
Example
Closing date: May 7. Seller already made her
May 1 mortgage payment. Loan balance is
$98,550, interest rate is 10%. How much
interest will seller owe at closing?
$98,550 × .10 = $9,855 annual interest
$9,855 ÷ 365 = $27 per diem
May 1 through May 7 = 7 days
$27 × 7 days = $189 debit for seller
© 2011 Rockwell Publishing
Prorating Interest
Buyer’s prepaid interest
Prepaid interest: Mortgage interest buyer pays
at closing to cover period from closing date until
end of month in which closing occurs.

Necessary because buyer not required to
make loan payment the month following the
closing month.

If closing date Aug. 12, first loan payment
due Oct. 1. First payment includes interest
for September, but not interest for August.
© 2011 Rockwell Publishing
Buyer’s Prepaid Interest
Example
Closing date: Sept. 9. First loan payment due
Nov. 1. Loan amount $156,000, interest rate
9%. How much prepaid interest will buyer
owe at closing?
$156,000 × .09 = $14,040
$14,040 ÷ 365 = $38.47
Sept. 9 through Sept. 30 = 22 days
$38.47 × 22 days = $846.34
© 2011 Rockwell Publishing
Prorations
Rent from income property
When income-producing property sold, may
be necessary to prorate rent.
 Rent usually paid in advance.
 At closing, seller pays buyer prorated
share of rent already collected for
month in which closing occurs.
 Note that security deposits are not
prorated.
© 2011 Rockwell Publishing
Settlement Statements
Cash at closing
To determine balance due to seller (amount
seller will take away from closing):
 add up seller’s credits
 add up seller’s debits
 subtract seller’s debits from seller’s
credits
© 2011 Rockwell Publishing
Cash at Closing
Balance due to seller
On simplified settlement statement, balance
due to seller listed in seller’s debit column.
 That way, total in seller’s debit column
equals total in seller’s credit column.
© 2011 Rockwell Publishing
Cash at Closing
Balance due from buyer
To calculate balance due from buyer (amount
buyer needs to bring to closing):
 add up buyer’s credits
 add up buyer’s debits
 subtract buyer’s credits from buyer’s
debits
Balance due from buyer entered in buyer’s
credit column.
© 2011 Rockwell Publishing
Settlement Statements
Column totals
Remember that buyer’s column totals don’t
have to match seller’s column totals; in fact,
they virtually never will.
 It’s as if each party has own checkbook,
and each checkbook must be balanced
separately.
© 2011 Rockwell Publishing
Summary
Prorations and Cash at Closing
•
•
•
•
•
Proration
Per diem rate
Prepaid interest
Balance due from buyer
Balance due to seller
© 2011 Rockwell Publishing
Income Tax Aspects of Closing
Federal income tax laws that apply to real
estate closings:

Form 1099-S reporting

Form 8300 reporting

FIRPTA
© 2011 Rockwell Publishing
Income Tax Aspects of Closing
Form 1099-S reporting
Escrow agent or other closing agent required
to report sale of real property to IRS.

Sale reported on Form 1099-S, with:
 seller’s name
 seller’s social security number
 gross sale proceeds

Agent can’t charge separate fee for filing
1099-S.
© 2011 Rockwell Publishing
Income Tax Aspects of Closing
Form 1099-S reporting
Sale of principal residence exempt from
1099-S reporting requirement if:
 seller certifies that none of the gain is
taxable
 property sold for $250,000 or less
($500,000 or less if seller married)
Certain other transactions also exempt from
requirement.
© 2011 Rockwell Publishing
Income Tax Aspects of Closing
Form 8300 reporting
Escrow agent who receives more than
$10,000 in cash must report payment to IRS
using Form 8300.
 Form must be filed within 15 days of
receiving cash.
 Copy should be kept for 5 years.
© 2011 Rockwell Publishing
Income Tax Aspects of Closing
FIRPTA
Foreign Investment in Real Property Tax Act:
Federal law designed to prevent foreign
investors from evading tax liability on income
generated from sale of U.S. real estate.

Requires real estate buyer to determine
whether seller is “foreign person.”
 Not U.S. citizen, not resident alien.
© 2011 Rockwell Publishing
Income Tax Aspects of Closing
FIRPTA
If seller is foreign person, buyer must:
 withhold 10% of amount realized (sales
price)
 send money to IRS within 20 days of
closing date
In most cases, escrow agent handles FIRPTA
compliance for buyer.
 Many residential transactions exempt
from FIRPTA.
© 2011 Rockwell Publishing
RESPA
Real Estate Settlement Procedures Act:
Federal law regulating closing process for
most residential transactions.
 Goals of law:
 provide borrowers with closing cost
information to help them shop for
settlement services
 eliminate kickbacks and unnecessary
fees that increase closing costs
© 2011 Rockwell Publishing
Transactions Subject to RESPA
Federally related loans
RESPA applies to any federally related loan
transaction that is not exempt.
 Transaction federally related if:
1. loan is secured by residential
property; and
2. lender has a connection with the
federal government.
© 2011 Rockwell Publishing
Transactions Subject to RESPA
Federally related loans
Specifically, federally related loan secured by:
 property on which there is (or on which
loan proceeds will be used to build) a
dwelling with four units or less

condominium unit or co-op apartment

lot on which there is (or on which loan
proceeds will be used to place) a mobile
home
© 2011 Rockwell Publishing
Transactions Subject to RESPA
Federally related loans
In addition, lender:
 is federally regulated,
 has federally insured accounts,
 is assisted by federal government,
 makes loans through federal program,
 sells loans to Fannie Mae, Ginnie Mae,
or Freddie Mac, or
 makes real estate loans totaling more
than $1,000,000 per year.
© 2011 Rockwell Publishing
RESPA
Exemptions
RESPA does not apply to:
 purchase of 25 acres or more
 business, commercial, or agricultural loan
 vacant land (unless dwelling to be put on it)
 temporary financing (construction loan)
 assumption, if lender’s approval not
required or obtained
 seller-financed transaction
© 2011 Rockwell Publishing
RESPA
Requirements
Within 3 business days of loan application,
lender must give applicant:

HUD booklet that explains RESPA, closing
costs, and settlement statements

Mortgage servicing disclosure statement

Good faith estimate of closing costs (GFE)
 Applicant can’t be charged fees other
than credit report fee until GFE given.
© 2011 Rockwell Publishing
RESPA Requirements
Service provider disclosures
Special disclosures required if lender or other
settlement service provider:
 requires borrower to use specific service
provider (attorney, appraiser, etc.), or
 refers borrower to affiliated provider.
Use of affiliated service provider must be
optional, and fee estimates must be given.
Also, seller can’t require buyer to use particular
title company.
© 2011 Rockwell Publishing
RESPA Requirements
Uniform settlement statement
Closing agent must itemize closing costs on
uniform settlement statement (HUD-1 form).
 Must be given to buyer, seller, and lender
on or before closing date.
 Buyer (borrower) must be allowed to
inspect statement at least one business
day before closing, if requested.
© 2011 Rockwell Publishing
RESPA Requirements
Limit on reserve deposits
Lender can’t require excessive deposits into
reserve account for taxes, insurance, other
recurring costs.
 No more than necessary to cover
expenses when due, plus two-month
cushion.
© 2011 Rockwell Publishing
RESPA Requirements
Kickbacks and unearned fees
Lenders and other settlement service
providers (including real estate agents) can’t:
 pay or receive kickbacks or referral fees

pay or receive unearned fees for services
not actually provided

charge a fee for preparation of uniform
settlement statement, reserve account
statement, or TILA disclosures
© 2011 Rockwell Publishing
RESPA Requirements
Kickbacks and unearned fees
RESPA’s prohibition against kickbacks and
referral fees doesn’t apply to referral fees
between real estate agents.
© 2011 Rockwell Publishing
RESPA Requirements
Estimated vs. actual costs
Actual closing costs don’t necessarily match
good faith estimate.
RESPA has rules regarding which charges
may increase at closing.
 Can’t increase: lender’s points and fees;
transfer (excise) taxes.
 Total can increase by no more than 10%:
charges for required services if lender
chose or recommended service provider.
© 2011 Rockwell Publishing
Summary
Federal Laws and Closing
•
•
•
•
•
•
•
•
•
Form 1099-S reporting
Form 8300 reporting
FIRPTA
RESPA
Federally related loan
Good faith estimate of closing costs
Settlement service provider
Uniform settlement statement (HUD-1)
Kickback
© 2011 Rockwell Publishing